Share returns to be 'dull not dire'

DR Bill Mott, one of the City's most respected fund managers, has warned that UK shares will remain stuck in the doldrums this year - but he believes it is still possible to pick winners.

'It's time for investment realism after the late-1990s experience,' said Dr Mott. 'It is increasingly likely that the market is already discounting the extent of the economic revival and that from now on the London market will not make much progress for some time.'

However, he believes food sector companies such as Dairy Crest and Northern Foods will benefit as the balance of power shifts from food sellers to food makers. He also predicts construction and building material companies to boom thanks to increased public spending. Building material firm BPB is a key holding in his largest fund.

Dr Mott, who has a PhD in quantum physics, successfully ran the Credit Suisse Income unit trust from 1986 to 1996. He returned in March 2000 and injected new life into the under-performing fund.

Since then it has surged 36% while the FTSE All-Share has dropped by around 15%, making it second best performer in the equity income sector. It was only beaten by Dr Mott's smaller fund, CSAM Monthly Income, which rose 37%.

Mott's track record on calling the market last year was mixed. In spring he wrongly predicted the market would have rallied by year-end. But post-11 September he correctly predicted the rapid rally that followed and had switched from defensive stocks to those that benefit from economic recovery, known as cyclicals.

'At the time I suggested this was a tactical move and that at some future time we would return to our long term 'holy grail' of being in defensive, predictable, economically insensitive stocks,' said Dr Mott.

'During December I moved both funds some way back to our original defensive stance. In football terms, having scored on the break-away, we have now got men behind the ball again.'

Looking to the US, Dr Mott believes a quick recovery could be dangerous and merely 'postpone and increase the economic pain'. He says the imbalances created by companies overspending in the late 1990s need to be worked out of the system.

In the UK, a best case scenario suggests earnings per share will only rise 6% a year for the foreseeable future - calculated from 2% economic growth, 2% by making firms more efficient and 2% inflation. That suggests share prices, a reflection of earnings, will only achieve average returns of 6%.

The worst case scenario is that the slump in manufacturing will stop the consumer spending and spark a full-blown recession.

Amid the gloom, Dr Mott believes food manufacturers, which have historically performed poorly, will improve. Retailers such as Tesco and J Sainsbury have 'reached maturity' and to squeeze out more returns they will have to sell more 'higher value-added and convenience products'. This has already been seen with Tesco's Finest and Sainsbury's Taste the Difference ranges. Food makers reap bigger profits from such products.

The building materials sector, he says, is undervalued because public spending at home and abroad has been neglected for the past 25 years. That is set to change in the UK with the Government splashing out on major projects.

'The future economic and stock market landscape will be dull, but not dire,' says Dr Mott. But this will be a good thing injecting 'a dose of realism into the market' and helping investors realise double digit returns are history.

And Dr Mott's solution to such a market? 'In this environment, many predictable, defensive, high yield, low growth stocks will appear undervalued against the false expectations of growth from the rest of the market. We see opportunities in this anomalous pricing, which we believe will allow us to deliver attractive returns.'